The New Arthurian Economics

Friday, January 20, 2012

As economic theory developed and deepened, it became obvious that there was an inherent conflict between standard "micro-economic" theory, and factual observations of the business cycle. For theory tells us that, in the market economy, there is a continuing tendency to eliminate error and to "clear the market"; there is a tendency then, for losses to be minimized. So how could there possibly be periodic clusters of severe business losses, which constitute the onset of the panic, crisis or depression? The conclusion that most economists and observers unfortunately came to was that microeconomics does not realistically apply to the "macro" level.

Rothbard recognizes the "inherent conflict between standard "micro-economic" theory, and factual observations of the business cycle." Then he says:

It should be recognized that most business-cycle theories – Keynesian, Marxist, Friedmanite, or whatever – and remedies are grounded in the assumption that the cycle stems from some deep flaw in the free-market economy. But if micro-theory is correct, then it must apply to the "macro" sphere as well. The economy is not some entity split between a micro and macro half; it is a seamless web, inextricably linked together by the use of money and the price system. Therefore, whatever applies to one part of it must apply to all. The explanation for business cycles must somehow be integrated with the explanation of the micro-economy.

Rothbard betrays his special interest by defending the free market against criticism of "some deep flaw".

But of course, the flaw is not in the economy. The flaw is in the economics. See, for example, the logic of Rothbard's economics: Assume that "micro-theory is correct," and proceed from there.

And so we see – and this is the great insight of the "Austrian" theory of the trade cycle – that micro and macro economics are in harmony after all. The free market does tend to adjust harmoniously without boom and bust, without incurring clusters of severe business losses. It is government intervention in the market that creates the business cycle, and unfortunately makes the corrective adjustment of recessions necessary.

Rothbard takes the argument where he wants it to go, rather than letting the economy point the way.